The lifetime allowance (LTA) used to be out of reach for most but is now being factored in more and more with those looking to transfer out of a defined benefit scheme.
The lifetime allowance is the maximum allowable to be saved into a pension without paying an additional charge current allowance is £1,073,100 (2021-2022), however, it has been as high as £1.8m in previous years.
The penalty for breaching the LTA is a 55% tax levy on funds above the allowance if taken as a lump sum or 25% if taken as an income (you will pay income tax on withdrawal also, roughly equalising the tax paid as if taken as a lump sum).
The limit applies to the total value of all your pensions including Final Salary (Defined Benefit, DB) and Personal/Group personal pensions (Defined Contribution, DC) schemes.
The major difference between DB and DC schemes when it comes to the LTA is the way they are calculated for LTA purposes. With DC schemes it’s simply the fund value against the LTA whereas with DB schemes it’s the value of the annual income x 20, plus any tax-free cash.
The way that DB schemes are calculated most often means it uses substantially less of your LTA than the equivalent value of the offered transfer amount.
A DB offers an income of £20,000 with a lump sum of £100,000 or a cash equivalent transfer value of £600,000.
Using the DB LTA calculation method – 20 x £20,000 = £400,000 plus the £100,000 tax-free cash is £500,000.
Taking the Cash Equivalent Transfer Value is £600,000.
You are therefore using £100,000 more of your lifetime allowance by transferring the DB into a DC scheme, than taking the benefits directly from the DB scheme.
You should therefore consider carefully the advantages of transferring a DB scheme if the lifetime allowance could be breached.
Another factor to consider is the potential growth of the transferred scheme. If the resulting transfer takes you close to the limits, for example £900,000, any potential future years growth could trigger the tax charge. A way to avoid this could be to crystallise the funds before they reach the limit. This effectively prevents any future growth triggering the charge, at least until age 75, when there is a second LTA test.
Learn about What affects Defined Benefit transfer Values?
More on the Lifetime allowance